Operating in low-tax foreign jurisdiction

A U.S multinational corporation may be able to reduce its total tax costs by shifting income producing assets and activities to a foreign subsidiary located in a low-tax jurisdiction.

Shifting income to low-tax foreign subsidiary does not permanently avoid the residual U.S tax on low foreign earnings. It merely defers those taxes until the subsidiary repatriates its earnings its earnings through a dividend distribution.

Eventual repatriation of those earnings may be subject to foreign withholding taxes.

Operating in High-tax foreign jurisdiction

When a U.S corporation conducts business in a high-tax foreign jurisdiction, the resulting excess foreign tax credits increase the total tax burden beyond what it would have been if only the United States had taxed the foreign source income.

A strategy to eliminate the excess credits is to increase the proportion of the taxpayer’s worldwide income that is classified as foreign source for U.S tax purposes.

Another strategy is to blend low-tax and high-tax foreign source income with in a single limitation. This allows the excess limitation on the low-tax foreign source income to offset the excess credits on the high-tax foreign source income.

Planning for foreign reduction local tax incentives

One way to reduce foreign tax is to take advantage of the special tax exemptions and holidays that various countries offer as an incentive to locate particular types of operations within their borders. For example, Switzerland offers low tax rates for headquarter companies.

Debt Financing

It may be advantageous to finance high-tax foreign subsidiaries in a way that maximizes interest deductions and minimizes dividend payments. The potential advantages of debt financing provided by a U.S parent include a deduction in the high-tax foreign jurisdiction for interest paid to the U.S parent, as well as the possibility of lower foreign withholding taxes on interest payments, as opposed to dividend distributions.

Transfer Pricing

By altering its transfer pricing policy, a U.S. multinational corporation may be able to allocate a smaller portion of its worldwide profits to subsidiaries located in high-tax foreign jurisdictions.

Tax Treaties

Tax treaties can reduce foreign taxes by making use of permanent establishment provisions and the reduced withholding tax rates provided by tax treaties.

Tax treaties provide lower withholding tax rates on dividends, interest, and royalties derived from sources within the tax treaty country.

Foreign Holding Companies

A foreign holding company functions as the legal owner of a U.S. company’s foreign subsidiaries, provides offshore cash management and financing, and facilitates the acquisition and disposition of foreign operating companies.

Check the box election and qualified dividend income

The check the box rules and the preferential tax rate for qualified dividend income have impacted outbound tax planning for closely-held businesses. Under the check-the-box rules, a U.S citizen or resident alien can organize a foreign business entity that is treated as a corporation for foreign tax purposes but as a disregarded entity for U.S tax purposes.

Although U.S citizens and resident aliens cannot claim a code section 902 deemed paid credit with respect to a dividend from a foreign corporation, they can take advantage of the 20% maximum U.S tax on qualified dividend income, which includes dividends received from foreign corporations that reside in countries who have entered into an income tax treaty with the United States.

Tax Havens

In general, there are six principal characteristics of tax havens.

• A tax haven either imposes no income tax or imposes a tax on income that is low in comparison to the tax imposed by the taxpayer’s home country.
• A tax haven often protects the confidentiality of financial and commercial information. In so doing, the tax haven may adopt bank secrecy or similar internal laws that make it a crime to disclose this information to any person.
• Financial institutions, such as banks, frequently assume a dominant role in the tax haven’s trade or commerce, and its residents include those skilled in financial transactions, such as bankers, lawyers, and accountants.
• A tax haven normally possess modern communications facilities necessary to the conduct of financial and commercial affairs.
• A tax haven often does not impose currency controls or similar restrictions on foreign nationals.
• If the tax haven has a treaty network, the haven may offer benefits such as reduced tax rates on income tax by its treaty partners.

Tax Haven Incentives

Following is a list of special incentives that tax havens generally offer.

Countries that impose zero tax

These are jurisdictions that impose no tax on income, capital gains, gifts, inheritances, estates and trusts. Since these countries do not have treaty networks, they have no obligation to furnish tax information to other jurisdiction. Such countries generally charge an annual formation fee to registered companies. Bermuda is an example of such a jurisdiction.

Countries that impose low tax rate

In order to compete with havens that impose a zero rate of tax, these jurisdictions offer a low rate of tax combined with a treaty network. The treaty networks are useful in adding some degree of flexibility to tax planning. Ireland is an example of such jurisdictions.

Countries that impose no tax on foreign source income

These tax havens do not impose any tax on income earned from sources outside of the particular jurisdiction. These havens are especially attractive to the transportation industry when, for example, jurisdiction allows the registration of foreign flagship. Hong Kong is an example of such a jurisdiction.

Countries that impose a reduced rate of tax on offshore finance and trade oriented businesses

These countries usually impose a minimal or token tax to resident companies that do not conduct business or trade with in the haven. British Virgin Islands is an example of such a jurisdiction.

Countries that offer special inducements

In order to attract certain companies, such as holding companies, some jurisdictions offer significant inducements that may include privileged treatment with respect to income taxes, import taxes, customs, duties, etc. Ireland is an examples of such a jurisdiction.

In order to attract manufacturing facilities to their countries, some jurisdictions, such as Singapore, provide for various tax holidays on profits earned on products manufactured for export.

References:

Practical Guide to US Taxation of International transactions 9^th Edition

Robert J. Misey Jr.

Michael S. Schadewald

Publishers: Wolter Kluwer, CCH Incorporated.